Yesterday’s Summer budget was full of surprises. The implications of the announcements are significant, and in some areas quite surprising.
Today we are going to look at three areas in a little more detail; the implications of the new main residence Inheritance Tax nil-rate band (quite a mouthful!), the taxation of Dividend income for private investors and company directors, and the tapering of pension tax relief for high earners (and a quirk in the rules that may affect those earning far less than £150,000).
Inheritance Tax Changes
The introduction of the main residence nil-rate band was a manifesto commitment from the Tories and was therefore widely expected.
The biggest surprise is that the change won’t be immediate – the new relief will be introduced in April 2017, a year later than expected, and will initially be set at £100,000 per person, increasing to £125,000 in April 2018, £150,000 in April 2019, and finally to £175,000 in April 2020.
Another important point is that the allowance is kept if you decide to downsize. Anybody downsizing from yesterday will have an increased nil-rate band, although further details including any caveats are scarce. The biggest caveat is that the property (or proceeds from it) must be passed to a direct descendant.
The budget document mentions that estates valued at over £2M will have the main residence relief
The chart below from the Treasury shows how the chancellor arrived at the £1M figure, which would require a married couple to own a property valued in excess of £350,000 and left to their direct descendant(s), with other assets of more than £650,000.
How will the changes affect our clients? The following tables examine a few scenarios, and may help you to get an idea of your potential liability from 2020.
Single person
|
Value of family home |
Value of other assets |
Value of the estate |
IHT liability now |
IHT liability from April 2020 |
|
£175,000 |
£150,000 |
£325,000 |
Nil |
Nil |
|
£200,000 |
£300,000 |
£500,000 |
£70,000 |
Nil |
|
£250,000 |
£400,000 |
£650,000 |
£130,000 |
£60,000 |
|
£400,000 |
£600,000 |
£1,000,000 |
£270,000 |
£200,000 |
|
£750,000 |
£750,000 |
£1,500,000 |
£470,000 |
£400,000 |
|
£1,000,000 |
£1,000,000 |
£2,000,000 |
£670,000 |
£600,000 |
Married couple
|
Value of family home |
Value of other assets |
Value of the estate |
IHT liability now |
IHT liability from April 2020 |
|
£175,000 |
£150,000 |
£325,000 |
Nil |
Nil |
|
£200,000 |
£300,000 |
£500,000 |
Nil |
Nil |
|
£250,000 |
£400,000 |
£650,000 |
Nil |
Nil |
|
£400,000 |
£600,000 |
£1,000,000 |
£140,000 |
Nil |
|
£750,000 |
£750,000 |
£1,500,000 |
£340,000 |
£200,000 |
|
£1,000,000 |
£1,000,000 |
£2,000,000 |
£540,000 |
£400,000 |
The Treasury is forecasting lower overall tax receipts from IHT once the relief starts, but these changes highlight the importance of ongoing reviews when estate planning.
Changes to Dividend Income Taxation
Major changes are afoot in the taxation of dividends, with the chancellor announcing the removal of the notional 10% dividend tax credit, to be replaced by a £5,000 dividend-specific personal allowance and tax rates of 7.5%, 32.5% and 38.1% for basic, higher, and additional rate taxpayers respectively.
Most of our clients will be protected from this change thanks to the use of Stocks & Shares ISAs and pensions, but those who are reliant on large dividend streams from Save-as-you-Earn schemes run by their employers, or shareholding directors who rely on dividends as their main income are likely to be hit the hardest.
The effective difference, ignoring the £5,000 allowance, is shown here:
| 20pc taxpayers | 40pc taxpayers | 45pc taxpayers | ||
| Effective dividend tax rate now | 0pc | 25pc | 30.56pc | |
| Rate after April 2016 | 7.5pc | 32.5pc | 38.1pc | |
A typical investor will only receive dividends from around half of their investment portfolio, and using an average dividend rate of 4%, they would need “unwrapped investments” of more than £250,000 before this meant an increase in tax, thanks to the tax-free allowance.
As mentioned above, the tax bites where shareholding directors draw dividends. We reckon that somebody drawing £40,000 in dividend income and £10,000 in salary will be £500 or so worse off in the 2015/16 tax year as a result of the changes.
Tapering of the Annual Allowance and Large Pension Contributions
The Chancellor had previously spoken of his intention to cap tax relief for the highest earners, with industry commentators predicting that tax relief would be capped at 20% for those earning over £150,000.
What was revealed in the budget was quite different; the annual allowance (that is, the maximum annual contribution that will receive tax relief in a given year) will be tapered from £40,000 to £10,000 for those with “adjusted income ” over £150,000, at a rate of £1 reduction per £2 over the trigger level. This means that somebody with adjusted earnings of £210,000 or more will have an annual allowance of £10,000.
Why the focus on “adjusted income”? This definition includes earnings plus employer and employee pension contributions. An example would be somebody with £130,000 of earned income and an employer contribution of £25,000 – in this case their annual allowance would be reduced by £2,500 to £37,500. Any further pension contributions would result in the annual allowance being further reduced by half the contribution amount.
The Treasury have included a minimum trigger of £110,000 of “non-adjusted earnings” before the tapering applies, which is very welcome as otherwise it could affect those using the “carry-forward” of annual allowances, which is a perfectly legitimate planning exercise.
Our main concern is for high-earners with final salary (also known as defined benefit) pensions, where their pension accrual produces a notional contribution which is outside of their control. We are watching closely to see if the pension schemes will have tools available to try and ease this burden.
